1. Field of the Invention
This invention relates generally to the detection of insurance policyholders who make fraudulent statements, take fraudulent actions or in some way misrepresent themselves in order to reduce the premiums they pay. In particular, the invention relates to an automated fraud and abuse detection system using predictive modeling (statistical analyses) in order to identify policyholders having high suspicion of premium fraud.
2. Background of the Invention
Insurance fraud is currently receiving unprecedented attention. Recent statistics support the focus on this criminal activity. In Conning & Company's 1996 study, Insurance Fraud: The Quiet Catastrophe, U.S. insurance fraud losses are estimated to exceed $120 billion annually. In general, however, respondents to the Conning & Company survey underestimated the overall cost of fraud, so while the overall savings from fighting fraud has reached $5 billion per year, this still leaves at least $115 billion being lost every year to insurance fraud. The industry as a whole has much work to do in order to significantly reduce fraud losses. The typical return on investment for fraud fighting efforts in 1995 was 6.88:1, up from 5.84:1 in 1994. The Conning and Company study concludes that from a cost-benefit perspective, insurers still have significant room to maintain, and even improve, their return on investment from fighting fraud.
One type of insurance fraud is premium fraud, in which the policyholder misrepresents policy-related information in order to fraudulently reduce the amount of insurance premiums paid to the insurer. FIG. 1 illustrates how premium fraud arises in insurance relationships, and how insurers respond to it. In FIG. 1, a policyholder is an entity that obtains an insurance policy from an insurer. The policyholder may be a business or an individual. The policyholder wishes to minimize exposure to certain risks, such as the risk of loss of life, health, livelihood, property, or profitability or the like, for which there are corresponding forms of insurance (e.g., life, health, disability, home and automobile, and liability insurance). These risks may arise as risks to persons such as the employees, children, and others who are generally understood to be under the control or supervision of the policyholder or risks to property also under the control, ownership or supervision of the policyholder. The policyholder and/or those persons under the control or supervision of the policyholder generally engage in activities which may result in losses to the policyholder, persons under the control or supervision of the policyholder, or third parties. The policyholder purchases insurance from an insurer such that those losses that are suffered by the policyholder directly or that would (in the absence of insurance) result in claims made against the policyholder become, by proxy, claims against the insurer. The insurer insures the activities by compensating the claimants in accordance with the terms of the policy.
To determine the premium that is needed to underwrite the policy, the insurer must have a way to quantify the risks that it faces in insuring the policyholder. To quantify the risks, the insurer obtains various types of data from the policyholder, that variously measures the policyholder's and the claimants current and past behavior and/or attributes (including the value of objects owned) relevant to the policy that is being purchased. These measures are generally described herein as “activity measures.” The activity or attributes being measured by an activity measure will vary depending on the type of insurance. In the context of workers' compensation insurance, the activity being measured is the amount of work in specific jobs, since that is where the risk of injury occurs. An attribute is the industry in which the insured company operates. In automobile insurance, for example, the activity and attributes include type of car, miles driven, and characteristics of the primary driver. In homeowner's insurance the activity and attributes include the value of the home, safety precautions used in the home, and the risk of natural disasters. The activity and attributes are reported by the policyholder to the insurer, who calculates the premium that the policyholder pays.
Because the insurer bases the premium on the perceived and quantified risks to the policyholder, the policyholder has an incentive to misrepresent himself as less risky than he actually is, and thereby to reduce the premium, i.e., to commit premium fraud. As shown in FIG. 1, it is generally the responsibility of the insurer to guard against premium fraud and abuse. Insurance companies conventionally attempt to limit premium fraud in two ways: (i) by carefully screening applicants for policies (underwriting); and (ii) by auditing and/or investigating policyholders. While selective underwriting can eliminate some applicants whose policy information appears suspicious, once an applicant becomes a policyholder there is an ongoing risk of premium fraud. Thus audits and investigations are important tools in an insurer's defense against premium fraud.
The object of an audit is to recover premium due, but not invoiced, because information used to determine premium was inaccurately declared by the policyholder. Audits also assist underwriting by setting a baseline of accuracy from which to build future underwriting decisions. A successful audit results in accurate premium adjustments for past policy periods and the recovery of premium owed.
Given the costs involved in an audit, not every policy can be audited. Rather, it is desirable to select and audit those policies most likely to involve inaccuracies that will result in substantial premium recoveries. Therefore, the effectiveness of using audits or investigations for recovering premium lost to fraud or abuse depends on the method used to determine which policyholders to audit or investigate.
Historically, insurers have developed various ad hoc procedures for selecting policies to audit. For example, an insurance company may choose to audit its large policies, on the grounds that they will catch the fraud and abuse that involve large premium amounts. Or an insurer may audit policyholders using geographical screening measures, such as auditing policyholders in selected zip codes. Another choice is to audit particular policyholder groups known to have higher incentives for premium misrepresentation, such as those that face particularly high rates for insurance. Such ad hoc methods for choosing policies to audit are reasonable if the auditors lack a way to assess individual policies for the likelihood of premium fraud. However, they result in auditing a great many policies that are honest (false positives) while many fraudulent policies are never caught (false negatives).
When misrepresentation is found through an audit, several possible actions may be taken. The auditor may correct the problem on a going forward basis; the insurer may bill the policyholder for back-premium due; the policy may be canceled; or the policyholder may be referred to the insurance company's Special Investigations Unit for possible prosecution.
An area with one of the greatest potentials for savings in reducing premium fraud, according to the Conning & Company study is workers' compensation insurance. Workers' compensation insurance is purchased from an insurer by employers (policyholders) to compensate their employees (claimants) for medical and/or disability expenses should an employee suffer a work-related injury.
Fraud and abuse in workers' compensation insurance may be committed by a claimant (exaggeration of injury, malingering, drug-abuse, double-dipping, etc.), employer (misrepresentation of payroll and employee class codes), or health care provider (over-servicing, collusion with claimant, etc.). Over the ten-year period from 1985-1994, 36% of property-casualty insurance fraud was in workers' compensation claims totaling about $5.9 billion per year. A significant portion of that total consists of premium fraud. A study by the California Department of Insurance found, that losses on premium fraud can and usually do exceed the amount of loss on claimant fraud and, in some instances, provider fraud.
The motivation for employers to commit premium fraud by misrepresenting payroll information is significant because insurance premiums form a substantial share of an employer's total cost, directly reducing overall profitability of the company.
Typically, the premium for a workers' compensation policy depends on:                The job classifications of the policyholder's employees. The rates for the classifications vary according to the risk of accident and injury in each type of work.        The amount of payroll paid to workers in each classification. Employers report to their insurers the amount of payroll in each job classification on a form called a payroll report.        The injury rate in the policyholder's establishment compared with other employers in the same industry. Workers' compensation insurers typically seek to reward employers who consistently operate safer-than-average businesses with lower premiums and to assess higher premiums from employers who operate businesses with higher-than-average injury rates. To achieve this goal, policyholders receive experience ratings, either from a rating bureau (such as the experience modification from the National Council on Compensation Insurance (NCCI)) or directly from an insurer (sometimes called a Safety Record Discount). These ratings are used to scale the policyholder's premium up or down, depending on that employer's historical injury rate compared with other firms in the same industry.        
There are a variety of techniques by which an employer can misrepresent policy information in the context of worker's compensation insurance:                The workers' compensation premium for an employee is proportional to his or her salary; an employer can thus reduce premiums by under-reporting payroll figures.        Additionally, premium rates vary greatly by occupation providing an incentive to misrepresent employees occupations Consider an individual with an annual income of $50,000. A typical premium for insuring a construction supervisor at that salary is approximately $300 (class code 5606), while a typical premium for a roofer with that salary is about $11,000 (class code 5551). Fraudulently claiming the roofer as a supervisor would result in significant premium savings to the employer. If that would be too suspicious, then the employer could claim the roofer as an electrical wiring installer (class code 5190), and reduce the premium to less than $3,000, still a substantial savings.        An employer can hide a poor claims history by closing the company and re-opening it with a new name. This action effectively resets their experience rating to a neutral position (a multiplication factor of one) thereby avoiding detrimental experience modification of the premium.        
Substantial reductions in premium can be achieved through these types of fraud. While these examples are particular to workers' compensation, there are analogous acts of misrepresentation in other areas of insurance. For example, misrepresenting a driving record or the identity of the primary driver on an auto policy application.
The Auditing Department of an insurance company is the front line of defense in detecting insurance fraud and abuse, including premium fraud and abuse. There are typically two types of audits—field audits and desk audits. A field audit involves the auditor visiting the policyholder and personally inspecting the facilities and books of the policyholder to confirm policy information and identify any misrepresentations. A desk audit is based on a review of documents requested from the policyholder. Many insurers are trending to an increasing number of desk audits, first to handle an increasing number of audits generally, and because they are easier and less costly to conduct. However, they are also more open to manipulation by the policyholder than are on-site field audits.
Historically there have been no automated statistical-based tools that assist auditors in identifying the most suspicious policies for auditing. Accordingly, it is desirable to have an automated system that uses available information regarding policyholders to analyze insurance policies, and periodically highlight policies that are likely to be engaged in premium fraud by misrepresenting information provided to the insurer. Such a system should enable the insurer to prioritize policies for auditing or investigating and should capture a relatively high proportion of the frauds while maintaining a relatively low false-positive rate (a false-positive is a policy that scores high but is not fraudulent). The effectiveness of such a system depends upon its ability to handle a large number of interdependent variables. In addition, the long-term effectiveness of such a system depends on the capacity for redevelopment of the underlying detection techniques as new patterns of fraudulent behavior emerge.